Kiel Working Papers, Kiel Institute for World Economics
No 1368:
Inflation Dynamics and Labor Market Dynamics Revisited
Tommy Sveen and Lutz Weinke
Abstract: Firms adjust labor both at the intensive and at the
extensive margin (see, e.g., Hansen and Sargent 1988). Moreover, employment
adjustment is not frictionless (see, e.g., Mortensen and Pissarides 1994).
What does this imply for inflation dynamics? To address this question we
develop a New Keynesian model featuring two margins of labor adjustment as
well as a simultaneous price-setting and employment decision at the firm
level. We find that the presence of an empirically plausible labor
adjustment decision at the firm level rationalizes strategic
complementarities in price-setting which help explain in‡ation dynamics.
27 pages, June 2007
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